What a Relative Strength Indicator is and how to use it.
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Trading Relative Strength Index strategies involves simple strategies which if followed can be rewarding for the trader.
The purpose of the Relative Strength Index (RSI) is to calculate the comparative changes that happen between the higher and the lower closing prices. The index is used by traders to establish overbought conditions and oversold conditions which in turn presents them with extremely valuable information to help them set their entry levels and exit levels in the currency markets. The RSI is an oscillator and its line ‘oscillates’ between the values of zero and one hundred. The values of 70 and 30 are considered important values because above and below them are the overbought and oversold regions respectively. Any value above 84 is considered a very strong overbought situation and generates a ‘sell’ signal, whereas any value below 15 is considered a very strong oversold situation and generates a ‘buy’ signal.
How to Trade an RSI Strategy:
The very good and simple strategy is to use the RSI to generate a buy or a sell signal. The RSI should be set to the customary 14 periods with a 9 period MA and with the 70 and 30 levels marked as red lines. Using the NZD/USD price chart below showing a 30 minute time frame with a 9 period MA we will cover a simple buy strategy.
On the 25th of January the RSI generated a buy signal in the area that is circled. It had given a false signal a few hours earlier when the signal line dropped to 24.56. After bouncing the signal line dropped below the 70 again dipping to 28.47. This time the 9 MA followed it, both on the RSI indicator and the candlestick chart and positive buy signal was generated. There followed a 249 pip rise in price before the index turned down again.
This next strategy shows sell signal and a buy signal on the same chart. Here we have a EUR/USD 1 week chart.
A sell signal is generated in December 2010 when the index turns down from an overbought condition around 75.60 shown by the blue arrow and then dips down to an oversold condition below the 30 line in June 2010, thereby generating a buy signal as shown by the red arrow.
Finally, another very simple forex trading strategy, which is an impressive trading system using two indicators; the RSI and the 5 period moving average. This strategy can be applied to any currency and is best used on a daily chart. Daily charts strategies are ideal for traders who wish to take on a buy and hold strategy.
The rules for this strategy are straight forward in that if the RSI is greater than 50 and the price has crossed up over the 5 period moving average by 10 pips it signals a buy entry.
If the RSI is less than 50 and the price has crossed down over the 5 period moving average by 10 pips it signals a sell entry.
In the daily chart above there 4 entry points, two sell signals and 2 buy signals. The exit point for a trader in this strategy would be a logical take profit and the use of a trailing stop. My preference is to wait until the index is just about to move back across the 50 line.